VALUE ADDED TAX

If your annual turnover exceeds £85,000 and you are not in any special category, then you must normally charge Value Added Tax at 20% on all your sales after you register with HM Revenue & Customs. This could mean that HMR&C are making more profit from your business than you are, and you may have difficulties in dealing with this. Please read this page to see what you can do.

If you give credit, or in other words, you send an invoice and then wait for payment, then it is useful to know about debt collection. There is a companion to this website which tells you the basics and you can find it byclicking here. The companion site also tells you about the Cash Accounting Scheme, which is a VAT scheme where you can wait until you get paid before you need to pay VAT to HMR&C. If you never get paid, then you get automatic bad debt relief on the VAT element.

If you suspect that you might need to register for VAT, then see an accountant. VAT can be a tricky and unpleasant tax to deal with, and if you just go ahead and register yourself, it can easily end in grief.

Our Analysis Spreadsheet

Once one or two VAT returns have been submitted, it is suggested that VAT return statistics be monitored to get an idea of your average VAT fraction. We have a specialist Excel spreadsheet which enables entry of the details of one or more previous VAT returns to get an idea. Once you know, then if you are using cash accounting it is possible to multiply any cash receipts by the average VAT fraction to estimate how much cash to put by to meet your upcoming liability to HMR&C. If we do your VAT returns, then we will complete our analysis spreadsheet and let you know the results.

You may have a copy of the completed spreadsheet if you are interested in seeing it. Here is an example to give you an idea of what it does:

In this example, results from the last three VAT returns have been typed in, and the spreadsheet shows the average VAT fraction as 12.8%. In general terms, any income you receive may be multiplied by 0.128 to get an estimate of the upcoming VAT liability, assuming that any VATable expenditure you need to make will be proportional to sales in the same ratio as in previous quarters.

The Flat Rate Scheme

There is another VAT scheme called the Flat Rate Scheme which allows you to apply a standard VAT fraction for your industry in order to work out your VAT liability, and if you account for VAT on the cash basis as well then you will have certainty about your liability to HMR&C. If your average VAT fraction is higher than the standard VAT fraction for your industry, then you should save money in adopting the Flat Rate Scheme, and our analysis spreadsheet will highlight all the industries which would benefit from a switch to FRS if they had the same average VAT fraction as you. Let us continue the above example with a calculated rate of 12.8%. Our spreadsheet would show this:

This spreadsheet shows that if your business is catering services, entertainment, journalism or anything below these activities, then you might be better off switching to FRS. If your business is the provision of secretarial services, hairdressing, beauty treatment or anything above these activities, then you would do best to stay put.

If you click on the picture, you can see the list of business categories sorted into alphabetical order.

VAT at 20% is a high rate, and a business just over the £85,000 threshold may find that there is a distortion of competition compared with a business just under the threshold. An intermediate VAT regime such as FRS may give some relief here in some industries, so we are happy to run this VAT fraction monitoring for all our clients as part of our regular accounts work and to advise you on what would be best for you. You should certainly know what your typical VAT fraction is, even if you do not take up FRS.

The Roundabout System

We can give you a free Excel spreadsheet which can hold three month’s worth of transactions. When you send it back to us by e-mail or on a memory stick, we will send you a replacement spreadsheet for the following quarter, which we call the roundabout system, and then prepare your VAT return. You will get an opportunity to approve the return before it is submitted electronically.

If you take up FRS, you normally just account for VAT based upon sales. We can give you another free spreadsheet to use every quarter for FRS. We will then prepare your VAT return, e-mail you a copy for confirmation, and then make an electronic submission. Note that at the same time, we are collecting information to use in preparing the annual accounts, and there is no duplication of work in the all-electronic spreadsheet system we use, which also generates our working papers on the side. You can see examples of all our bookkeeping systemsby clicking here.

If you start using FRS, input tax is no longer claimed since an allowance for it is built in to the scheme, which saves you having to process a large number of small invoices. However, if you purchase any capital goods with a total invoice value of more than £2,000 inclusive of VAT, such as a computer or a van, then you can claim for the input tax under FRS. Please just scan and e-mail to us a copy of any relevant invoice.

Of course, if you buy a computer, you may want a bottom line of more than £2,000 which may mean buying two computers or other equipment on the same invoice at the same time. You might also buy something substantial just before starting FRS while you can still claim for it. We would warn you to be careful to see that the invoice is capital goods only since a mixture of capital goods and other items could be disallowed during a visit by a VAT officer.

The FRS rates in the first year are 1% lower, but we feel that this does not really compensate for the fact that you are likely to be buying quite a few capital goods worth a bit less that £2,000 in the early years of a new business, and for the fact that adoption of FRS is a one-way decision.

FRS Conditions

To adopt FRS you need to be registered for VAT, but to have a VAT-exclusive turnover of less than £150,000. Once on FRS you will need to leave it if VAT-inclusive turnover exceeds £230,000. FRS is probably best suited to businesses in the nature of consultancies selling their labour or professional skills with no purchases for resale and few overheads.

If you have subcontractors then you may need to give some thought to the VAT position. If your subcontractors are registered for VAT, then FRS may be unattractive to you since you cannot now reclaim the VAT shown on their invoices. If your subcontractors are not registered for VAT, then FRS may look more attractive because notionally you are reclaiming their deemed input tax. This will all be figured in to the analysis spreadsheet calculation, but remember that once you switch to FRS, you will prefer subcontractors who are not VAT-registered. A discussion with an accountant is strongly recommended.

HMR&C are happy with FRS because it simplifies the checking work they need to do when they come out to visit you, and fewer errors are likely to be made. However we need to set up an efficient active market for FRS-type schemes and our analysis spreadsheet aims to do this.

Let’s say for the sake of argument that you do not claim any input tax whatsoever. Your turnover is just over £85,000, and you switch to FRS, but you are on the top rate of 14.5% which is typical of professional services. Your annual VAT bill before FRS would be £17,000. Your annual VAT bill on the change to FRS would be £14,790, so the FRS saving would be £2,210 which isn’t wonderful, but at least it is worth having. In practice you might make savings in the £1,000 – £2,000 area.

We won’t oversell FRS on the basis of the savings to be made, but what is useful is that you no longer have to process big piles of invoices, making it a bit easier to deal with your accountant by e-mail, and with us you get the extra benefit of having your annual accounts being built up at the same time. Fewer invoices to be processed means fewer mistakes are likely to be made. All these benefits taken together may influence your decision.

The VAT threshold has been £85,000 since 1st April 2017 and did not change in 2018.